Monday, January 21, 2013

Joseph Stiglitz: Why Macro economics failed to see financial crisis coming and cannot provide solution

In his lecture at the University of Hyderabad (hat tip The Big Picture and Zero Hedge), Professor Joseph Stiglitz explains why macro economics was unable to predict the financial crisis and much, much worse, why it does not have any basis for the advice it offers on how to fix the problem.

The lecture is well worth listening to as Professor Stiglitz explains some of the assumptions that go into the standard model used by central banks and macro economists.  These assumptions included no financial sector as well as perfect operation of the invisible hand (the model excluded the possibility of either information asymmetry or "lemons").

As previously discussed by your humble blogger, the Fed is diligently working to adjust its model to include the financial sector.

However, nobody has adjusted their model to deal with opacity in all the different corners of the financial system (information asymmetry and lemons are examples of opacity).

The fact that the macro economists' standard model is fundamentally flawed is directly linked to the simple reality that the solutions they have championed to recover from the financial crisis have not worked.

This is not surprising as macro economists were guessing as opposed to offering advice based on their expertise.

Unlike the macro economists, your humble blogger has not been guessing about what policies it will take to end the financial crisis.

The fact that I haven't been guessing shows in the numerous predictions on this blog about what policies will or will not work and the subsequent performance of the policies.

My track record of predicting the financial crisis and the efficacy of the different policy responses should not be a surprise because I am simply applying the FDR Framework on which most of the global financial system is based.

If you know what the problem is, it is easy to see what does or does not address it.

One question that Professor Stiglitz did not answer was why economists open up their mouths and offer policy recommendations that they will vociferously defend when, by training and practice, they have never studied the cause of the financial crisis.

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